Question

1.) The Dollar and the Pound. a.) Draw a market where the dollar is in equilibrium. Then assume there is a US income tax hike b.) Draw a market where the pound is in equilibrium. Then assume there is a UK income tax c.) Describe the market conditions in each case (excess demand/excess supply). cut. 2.) The Dollar and the Ruble. a.) Draw a market where the ruble is over-valued. b,) How do Russian policy makers act to defend an over-valued ruble? Explain your answer w it on the graph. ...See next pag

Answer 1

Answer 1(a) :

Answer 1(b) :

Answer 1( c) : As we can see in Figure 1 , the X axis represents the Quantity of Dollar in the market and the Y axis represents the Exchange rate. Here D1D2 is the market demand of dollar and S1S2 is the supply of dollar. Point M is the point of equilibrium in the market, where the supply and demand curves meet. Now, if the US Government levies a hike in the income tax, this will reduce the amount of available dollars at the hands of the people. The reduction of dollar in the hand of the people will reduce the supply of dollar in the market. Here the S1S2 curve shifts down to the S3S4 curve. When there is a reduction in the supply of dollar, the value of dollar increases which reduces the demand for Dollar in the market. Hence the equilibrium level also drops down to MMx from MM.

                                           Similarly, we can see in Figure 2 , the X axis represents the Quantity of Pound in the market and the Y axis represents the Exchange rate. Here D1D2 is the market demand of pound and S1S2 is the supply of pound. Point M is the point of equilibrium in the market, where the supply and demand curves meet. Now, if the UK Government levies a cut in the income tax, this will increase the number of available pounds at the hands of the people. The increase of pound in the hand of the people will reduce the increase of pound in the market. Here the S1S2 curve shifts up to the S3S4 curve. When there is an increase in the supply of pound, the value of pound decreases which increases the demand for pound in the market. Hence the equilibrium level also moves up to MMx from MM.

Answer 2(a) :

Answer 2(b) : As we can see in Figure 3 , the X axis represents the Quantity of Rubel in the market and the Y axis represents the Exchange rate. Here D1D2 is the market demand of Rubel and S1S2 is the supply of Rubel. Point M is the point of equilibrium in the market, where the supply and demand curves meet. The value of Rubel is so over-priced in the economy that a forced equilibrium M is achieved at a very low supply and demand of the Ruble in the market. In order to improve the situation and to defend the price of the Rubel in the market, the policy makers can cut down the tax rates in the economy and additionally invest huge amount of Rubel in the various economic sectors. The ax rate cut and influx of investment from the Government will increase the availability of Rubel in the hands of people, thereby devaluing the Rubel, and increasing the demand for Rubel in the market. This increase of the demand for Rubel will shift the economic equilibrium at Mx which will increase both the supply and the demand for Rubel in the economy.